On July 29, 2022, a person removes the nozzle from a pump at a gas station in Arlington, Virginia.
Olivier Douliery | AFP | Getty Images
Now you’d be hard-pressed to find a recession in your rear-view mirror. What lies along the way, however, is another story.
There is no historical precedent for a recessionary economy to produce 528,000 jobs in one month, as the US did in July. An unemployment rate of 3.5%, tied for the lowest since 1969, is not consistent with contraction.
But that doesn’t mean there isn’t a recession ahead, and ironically, it’s the phenomenal resilience of the labor market that could pose the biggest long-term danger to the broader economy. The Federal Reserve is trying to ease pressures on a historically tight employment situation and its rapid wage gains in an effort to rein in inflation at its highest level in more than 40 years.
“The fact is, this gives the Fed additional room to continue tightening, even if it increases the likelihood of pushing the economy into recession,” said Jim Baird, chief investment officer at Plante Moran Financial Advisors. . “It will not be an easy task to continue tightening without negative repercussions for the consumer and the economy.”
Indeed, after the robust jobs numbers, which included a 5.2% 12-month gain for average hourly earnings, traders accelerated their bets for a more aggressive Fed. As of Friday afternoon, markets were assigning about a 69% chance that the central bank would enact its third consecutive 0.75 percentage point interest rate hike when it meets again in September. according to data from the CME group.
So while President Joe Biden celebrated Friday’s strong jobs numbers, a much more unpleasant data point could be on the way next week. The consumer price index, the most closely followed measure of inflation, is out on Wednesday and is expected to continue upward pressure even with a sharp drop in gas prices in July.
That will add pressure to the Fed’s balancing act of using rate hikes to moderate inflation without tipping the economy into recession. As Rick Rieder, chief investment officer of global fixed income at asset management giant BlackRock, put it, the challenge is “how to execute a ‘soft landing’ when the economy is heating up and landing on a runway that I’ve never used it before.”
“Today’s print, which comes in much stronger than expected, complicates the job of a Federal Reserve seeking to engineer a more dovish labor environment, consistent with its attempts to moderate current levels of inflation Rieder said in a client note. “The question now, though, is how much longer (and higher) will rates have to go before inflation can be brought under control?”
More signs of recession
Financial markets were betting against the Fed in other ways.
The yield on the 2-year Treasury beat the 10-year note by the highest margin in about 22 years on Friday afternoon. This phenomenon, known as an inverted yield curve, has been a telltale sign of recession, especially when it persists over an extended period of time. In the present case, the investment has been maintained since the beginning of July.
But that doesn’t mean a recession is imminent, just that it’s likely to happen in a year or two. While that means the Fed has time, it could also mean the central bank won’t have the luxury of slow hikes, but instead will have to continue to move quickly, a situation policymakers had hoped to avoid.
“Certainly, this is not my base case, but I think we may start to hear some talk of a hike between meetings, but only if the next batch of inflation reports is hot,” said Liz Ann Sonders , chief investment strategist at Charles. Schwab.
Sonders described the current situation as a “single cycle” in which demand returns to goods services and poses multiple challenges to the economy, making the debate about if the United States is in a less severe recession than the one ahead.
That’s a view widely shared by economists, who fear the hardest part of the journey is yet to come.
“Although economic output contracted for two consecutive quarters in the first half of 2022, a strong labor market means we are probably not in a recession right now,” said Frank Steemers, senior economist at The Conference Board. “However, economic activity is expected to cool further towards the end of the year and it is increasingly likely that the US economy will slip into recession before the end of the year or early 2023” .